The Price We Pay

If we always made rational decisions that is based only on economic reasons the price we pay for products and services we buy should leave us feeling that these are worth more than it cost them. At the very least these two should match. The difference we perceive, between what the product is really worth to us and the price we paid is called the consumer surplus. But the problem with this is we are not all economists or rational number crunchers. I am going to exclude emotional decision making for this post and focus simply on our quantitative ability or the lack of it.

I do not mean our capabilities with numbers but our ability to assign a dollar figure to the value we derive from products and services. Imagine you have an hand held device that can read bar code and an LCD display. You read the bar codes of any product and it displays the value you will get. Then you look at the price and decide whether this leaves you a positive consumer surplus or not and decide whether or not to buy it. The value we get is our Willingness to Pay. We should be willing to pay any price up that and not more than that.

Unfortunately we do not have a device and even if there is one the device must not only work differently for each person since the value you get is different from mine and from everyone else but also work differently for the same person based on time and context.

There is no such device. So how do we know whether are not a product is worth the price we paid for it? We never will for sure. I have heard a simpler and better definition for consumer surplus, ” it is the size of the smile on our face after we buy the product”. If we kick ourselves for buying at a price obviously it means we paid too much.

The story does not end there, there are complexities like reference price, how marketing can increase our willingness to pay, how lack of value information (with no magic barcode reader) can artificially suppress our willingness to pay. There are emotional purchases in which we convince ourselves of higher willingness to pay or adjust our willingness to pay post-purchase to assuage our concerns of overpaying.

Now you know why microeconomics alone is not enough to define pricing strategies for marketers and the need for behavioral economics and behavioral pricing. I look forward to writing a few articles in behavioral pricing in the coming weeks.